Regulation of the capital markets around the world changed radically following the stock market crash in 1929. The unprecedented fall in share prices largely reflected the massive loss of confidence in the quality of information made available by companies and the brokerage houses that sold their stock. Governments responded by enlisting the accounting profession to help restore that lost confidence. Publicly-traded companies were required to report regularly on their financial condition in conformance with what have come to be known as “generally accepted accounting principles” GAAP). Governments required publicly-traded companies to engage audit professionals to attest to the fact that the information presented by company management actually did conform to those principles.
However, the world has changed dramatically in many different ways since the 1930s. Among other things, increasing globalisation has meant that the economies of different countries are much more closely linked — by trade and capital flows — than ever before. Technological change, especially in vastly improved communications, has led to information becoming both widely and instantaneously available.
Business is now also much more complex than it was in earlier times. Contractual relationships are more complicated, and the financial instruments that companies issue to raise capital and hedge risks are far more sophisticated than the comparatively simple loans and stock shares that were issued and traded in preceding decades. The value of many companies resides in various “intangible” assets (such as employee creativity and loyalty, and relationships with suppliers and customers and the social and environmental impact of their activities.). However, information to assess the value of these intangibles is not consistently reported.
Billions of people around the world now have the ability to access information instantaneously. Yet when it comes to assessing a company’s performance and prospects investors must wait for companies to publish a full account of the activities a year in arrears. The information technology revolution has made data customization easy to use and broadly expected. However, today’s corporate reports remain largely one-size-fits-all, and are not sufficiently accessible to many investors.
The same forces that are reshaping economies at all levels are driving the need to transform what kind of information various stakeholders want from companies, in what form, and at what frequency.
Moreover, because many enterprises increasingly are doing business in multiple countries while investors increasingly are buying the shares of companies from around the world, stakeholders and investors in particular want to know that the information they are getting is compiled, classified, reported and audited on a consistent basis across countries.
Over the years since 1929, corporate reporting standards and practices have been revisited many times, by governments, intergovernmental organisations and the accountancy profession. Where do we stand today?
There is an apocryphal story that the shortest corporate report was given by the chairman of a listed company at his company’s AGM. Asked by a shareholder to sum up the firm’s prospects for the year ahead he replied “I expect it to be an average year, by which I mean that it will be worse than last year but better than the year following.”
This is in sharp contrast to the complexity of information which today faces an investor or other stakeholder who wants to make a judgement about the future prospects of a company in which they have an interest.
A more wordy statement was made by the CEO of the Royal Bank of Scotland in April 2008 when presenting his company’s report for 2007.
“For the Royal Bank of Scotland Group, 2007 was defined by another strong operating performance and by the acquisition of ABN AMRO.
The diversity and quality of our business platform enabled us to deliver good financial results, with operating profit for the enlarged RBS Group rising by 9% to £10,282 million. Our earnings momentum remained powerful, notwithstanding the impact of challenging credit market conditions in the second half of the year.
Our results demonstrate the resilience of the Group in the face of testing circumstances...... The pace of activity in the US slowed as the housing market weakened, leading to challenging conditions for Global Banking & Markets (‘GBM’) and Citizens. Later in the summer began the dislocation in credit markets, which made the second half a turbulent period for the financial services sector.
Delivering such a robust financial performance in this environment is the consequence of action in two areas: over a number of years we have diversified the Group’s income streams and last year also saw us benefit from our focus on credit quality and risk management with our impairments, excluding ABN AMRO, down 1%.
The Group’s Tier 1 capital ratio at 31 December was 7.3% and our total capital ratio 11.2%, within our target ranges. At the time of the bid for ABN AMRO we indicated our intention to rebuild our capital ratios. We remain committed to this goal, and the improved financial returns now expected on the acquisition will help to accelerate delivery of the Group’s capital regeneration commitments........
In UK retail banking we anticipated that households would save more and successfully boosted our sales of savings and investment products. We focused on investing in customer service in UK Corporate Banking and have strengthened our market leading position. In the US our distribution and product capabilities now provide an excellent platform in the corporate and commercial markets.
The acquisition of ABN AMRO gives us the ability to accelerate our existing strategies for growth outside the UK, particularly in rapidly expanding markets, while adding complementary capabilities and customer franchises to our portfolio of businesses. The integration has made a strong start, and synergies are now expected to total €2.3 billion, compared with our original estimate of €1.7 billion.
It is tempting to think of the task before us in 2008 only in terms of the integration of ABN AMRO, and delivery of the substantial cost and revenue synergies. To do so, however, would overlook the real opportunities for the enlarged Group.
Whilst the future seems as difficult as ever to predict, it is clear that we enter 2008 with real momentum behind our organic growth, and with our product range, distribution capabilities and customer franchises materially enhanced. Coupled with our greater presence in the world’s largest and fastest growing economies, there is much to be done, but a confidence that it will be, to the benefit of our shareholders, our customers and our employees.”
“We believe ABN is a very responsibly run bank and we have no reason to believe they have any undue exposure”, RBS Chairman Tom McKillop said in answer to a shareholder question about whether ABN was exposed to troubled corners of the credit market.
A few short months later, in October 2008, after crisis talks, the Treasury and the Bank of England provided UK banks with £350bn in loans and guarantees, stabilising the banking system and preventing HBOS and RBS from collapsing.
"There was very little time. The government was announcing the terms on which it was prepared to come in and the banks had to think about it but they broadly had to accept it", according to the deputy governor of the Bank of England, Sir John Gieve.
A few months later, in January 2009 Shares in Royal Bank of Scotland collapsed on the news that the bank was facing the worst loss in UK corporate history.
The company's market value slumped below £5 billion after shares plunged by as much as 70 per cent at one stage.
Asked about the record losses, Prime Minister Gordon Brown voiced his anger about the bank's decision-making, in particular international investments "that were clearly wrong investments".
He added: "Today's write-off by the Royal Bank of Scotland is for irresponsible losses accumulated in American sub-prime markets that partly derive from the acquisition of the Dutch bank ABN Amro."
But what about the body of the report, the facts and figures. How far could this have conveyed to the discerning reader that there was trouble ahead?
The answer is that it was read by the experts, the fund managers who voted for the board at the AGM, and who overwhelmingly approved the acquisition of ABNAmro.
The report is a formidable document crammed with complex information. The financial data meet regulatory requirements. No fraud was attempted. Yet the system failed pension funds and savers.
RBS is not an isolated case. How and why this kind of thing happens is what we are investigating. The key question we are asking is:
What aspects of the current systems architecture and the behaviours, values and cultural dimensions of its stakeholders, prevent or support the effective development of corporate reporting?